Wage Setting and Sector-Specific Unemployment

Abstract

One of the main facts highlighted in the previous chapter is that, with very few except ions, neither the nominal nor the real wage level has fallen even in times of high unemployment. Therefore, any theory of unemployment must be able to explain which mechanisms prevent wages from falling to market-clearing levels. The three most predominant theories which explain such wage behaviour found in the literature are models of union wage bargaining, efficiency-wage theories or matching models and it is for this reason, that in line with this mainstream literature, the focus here will be on these three classes of models.1 The purpose of this chapter is to provide introductory analysis of these theories. Although this has the disadvantage that many realistic aspects are ignored and many simplifying assumptions need to be made, it has the advantage that the main concepts behind these models can be better illustrated and that a unified framework is developed which can then subsequently be modified. In this rudimentary setting, the models developed in this chapter will first analyse the effects of unions, efficiency wages and matching friction for the case that labour is treated as homogeneous, and then subsequently for the case that labour is heterogeneous with respect to skills. These frameworks provide the foundations for more complex and realistic settings developed in the subsequent chapters.